Hedge funds continue to attract boatloads of money, despite humdrum performance. And worse, people who should know better persist in investing in them for the wrong reasons.

In the New York Times a sophisticated institutional investor explains the logic:

This year ”is the third straight year that the global equity markets and long-only managers outperformed hedge funds,” said Christy Wood, senior investment officer for global equities at the California Public Employees’ Retirement System. ”If you threw all these in an index fund net of fees, you would have done better than if you put it in the hedge fund industry.”

So is Calpers pulling back? Not at all. Ms. Wood helps to oversee $4 billion in hedge fund investments and has another $3.5 billion to invest. She is satisfied that hedge funds have delivered exactly what Calpers wants from them: equitylike performance with bondlike risk.

”We are looking for a return stream that doesn’t behave like any others we have,” she said.

Superficially, this argument sounds unassailable (if one ignores the fact that hedge funds have not generated equity-like returns). Calpers likes hedge funds because they offer an attractive and distinctive risk/return profile. But there is no need to pay hedge fund fees (typically 2% annual management fees plus 20% of the upside) for that.

The rationale for hedge funds’ eyepopping fees is that investors are paying for “alpha,” that is, the excess return (meaning the return in excess of the “market” return). Investors are willing to pay for alpha because it is considered to reflect an investment manager’s skill, and managers who can regularly outperfrom the market are rare indeed.

But Ms. Wood is talking about something completely different. Targeting a particular risk/return tradeoff isn’t an alpha proposition at all. It is instead “synthetic beta,” (or “alternative beta”). And synthetic beta can be produced comparatively cheaply.

A 2005 survey (http://www.edhec-risk.com/edhec_publications/RISKArticle.2005-08-10.3923/view, free subscription required) found that 70% of the investors recognized the role of alternative beta in overall hedge fund results. But this knowledge hasn’t yet translated into a recognition that they are overpaying.

But some of the providers do, and are launching clones) to undercut hedge funds. Merrill Lynch introduced its Passive Factor Index earlier this year and claimsGoldman Sachs launched its “hedge fund replication tool,” Absolute Return Tracker Index ((http://www.ft.com/cms/s/5b8331c0-82fc-11db-a38a-0000779e2340.html), earlier this month. Experts believe they offer the same risk profile at lower cost.

Now synthetic beta can be very valuable (http://www.allaboutalpha.com/blog/2006/11/16/an-alphabeta-framework/) to investors like Calpers, who are managing retirement funds (they have to worry about meeting specific long-term commitments). But for an institution as savvy as Calpers to be frittering away its assets on unnecessary fees says that hedge funds seem likely to continue to pull in more assets.